CHAPTER 10

THE IMPORTANCE OF BUDGETS TO GOVERNMENTS

Introduction

Budget Background

Executive Budget

Appropriated Budget

Nonappropriated Budget

Budgetary Execution and Management

Budget Amendments

Budgetary Reporting

Which Funds of the Government Adopt Budgets?

General Fund

Special Revenue Funds

Capital Projects Funds

Debt Service Funds

Proprietary Funds

Fiduciary Funds

Differences between the Budget and GAAP

Basis of Accounting Differences

Timing Differences

Perspective Differences

Entity Differences

Budgetary Control

Summary

INTRODUCTION

Almost all organizations—governmental, commercial, or not-for-profit—operate using some form of budgeting to ensure that resources are used in accordance with management’s intentions and to facilitate obtaining results of operations consistent with management’s plans. In the governmental environment, budgets take on greater importance, because they provide the framework in which public resources are spent. From an accounting and financial reporting viewpoint, budgets in government are a key component in achieving the accountability objective described in Chapter 2. Budgets in government generally represent adopted law, which is far more significant than simply a financial planning tool. Because many governments do not follow GAAP to prepare their budgets, achieving the accountability objective by comparing a non-GAAP-based budget with GAAP-based results presents some unique challenges. GASBS 34 affirmed the importance of budgetary reporting by governments by incorporating such reporting, in certain circumstances, into the financial reporting model of governments. These requirements are described in this chapter.

This chapter provides an overview of the budgeting process in governments and highlights the important areas in which budget information is incorporated into the financial statements of governments.

BUDGET BACKGROUND

NCGAS 1, Governmental Accounting and Financial Reporting Principles, and NCGA Interpretation 10 (NCGAI 10), State and Local Government Budgetary Reporting, provide useful background information on the budgeting process typically found in state and local governments. One of the difficulties in understanding the budgeting process is the definition of a typical budgetary process, because it is the result of legislative actions, and accordingly, many governmental units are far from typical. However, the following discussion provides sufficient general information on the subject to enable governmental accountants and auditors to handle any budgeting situation encountered in any particular state or local governmental unit.

There are various components of a governmental budget.

• Executive budget
• Appropriated budget
• Nonappropriated budget

Executive Budget

The budgetary process typically begins with the preparation of an executive budget by the executive branch of the government (for example, the governor, mayor, or county executive) for submission to the legislature. NCGAI 10 defines the executive budget as “the aggregate of information, proposals, and estimates prepared and submitted to the legislative body by the chief executive and the budget office.” This budget represents the efforts of the chief executive to accumulate and filter all of the budget requests for spending authority submitted by the various agencies and departments of the government. It also includes estimates of the expected revenues and other financing sources that will be used to pay for that spending authority. In addition to specific agency requests, the executive budget should also reflect the executive branch’s calculations of expenditures for required payments. For example, expenditures for debt service are seldom at the discretion of the government in terms of amounts to be paid or whether the payments will be made. Pension contributions are another example of expenditures that are usually determined centrally by the executive branch.

Appropriated Budget

The executive branch usually submits the executive budget to the legislative branch of the government. After discussion and negotiation between the executive branch and the legislature, the legislature will pass the budget for signature by the executive branch. At this point, the budget is known as an appropriated budget. NCGAI 10 defines an appropriated budget as “the expenditure authority created by the appropriation bills or ordinances which are signed into law and related estimated revenues. The appropriated budget would include all reserves, transfers, allocations, supplemental appropriations, and other legally authorized legislative and executive changes.” The importance of the appropriated budget is that it contains the legally authorized level of expenditures (the appropriations) that the government cannot legally exceed.

Nonappropriated Budget

Certain aspects of the government may operate under a financial plan that does not need to go through the formal appropriations process described above. This type of budget is referred to as a nonappropriated budget. A nonappropriated budget is defined by NCGAI 10 as “a financial plan for an organization, program, activity, or function approved in a manner authorized by constitution, charter, statute, or ordinance but not subject to appropriation and therefore outside the boundaries of the definition of the appropriated budget.” The extent to which governments use nonappropriated budgets depends on the extent to which these types of expenditures are specifically authorized (as described in the definition).

Budgetary Execution and Management

NCGAI 10 defines budgetary execution and management as “all other sub-allocation, contingency reserves, rescission, deferrals, transfers, conversions of language appropriations, encumbrance controls, and allotments established by the executive branch, without formal legislative enactment. These transactions may be relevant for various accounting control and internal reporting purposes, but are not part of the appropriated budget.” Budget execution and management are the link between the higher-level appropriated budget described above and the more detailed budget that enables management of the government and its various agencies and departments to use the budget as a management and resource allocation tool.

Budget Amendments

After adoption of a budget for a government’s fiscal year, it often becomes necessary to make changes in the budget during the fiscal year. There are any number of reasons why budgets of governments might need to be amended. For example

• Tax revenues may fall short of expectations, requiring the approved level of expenditures to be decreased
• Unusual weather circumstances (above normal snowfalls, hurricanes, floods, etc.) may result in the unforeseen use of significant amounts of a government’s resources
• Policy issues developing during the year may result in a government desiring to shift spending authority to new or different programs
• Overtime and employee benefit costs may be more or less than expected

When budgets are legally adopted, the budget modification process will be dictated by the local laws of the government. Frequently, government agencies are given the ability to shift budgetary funds for relatively small amounts among their various budget categories. In addition, there may be limits as to shifting funds between budget amounts for personal-service expenditures and other-than-personal-service expenditures. When budgetary changes are for other than insignificant amounts, the legislative body will usually be required to adopt a budget amendment to formally amend the budget.

As part of the local requirements mentioned above, the period of time during which the budget may be modified will vary among governments. For example, a budget amendment adopted on the last day of the government’s fiscal year provides no control over the use of governmental resources, but may be used by a government to disguise large variances from an originally budgeted amount. Local laws may prevent this type of manipulation, although some governments actually have the ability to modify their budgets months after the end of their fiscal year.

Budgetary Reporting

GASBS 34 requires governments to include in Required Supplementary Information (RSI) a budgetary comparison schedule containing original budget amounts, final budget amounts, and actual amounts for the general fund and for each major special revenue fund for which a budget is legally adopted. Instead of presenting their information as RSI, a government may elect to report the budgetary comparison information in a budgetary comparison statement as part of the basic financial statements. The actual amounts presented should be on the same basis of accounting that is used for the budgeted amounts. Variance columns are encouraged, but not required. GASBS 37 requires disclosure of excesses of expenditure over appropriations in the general fund and for each major special revenue fund that has a legally adopted annual budget.

The following definitions are provided in GASBS 34 to distinguish the original budget from the final budget:

• The original budget is the first complete appropriated budget. The original budget may be adjusted by reserves, transfers, allocations, supplemental appropriations, and other legally authorized legislative and executive changes before the beginning of the fiscal year. The original budget should also include actual appropriation amounts automatically carried over from prior years by law. For example, a legal provision may require the automatic rolling forward of appropriations to cover prior year encumbrances.
• The final budget is the original budget adjusted by all reserves, transfers, allocations, supplemental appropriations, and other legally authorized legislative and executive changes applicable to the fiscal year, whenever signed into law or otherwise legally authorized.

In addition, Management’s Discussion and Analysis is required to include an analysis of significant variations between original and final budget amounts, and between final budget amounts, and actual budget results for the general fund, or its equivalent. The analysis should contain any currently known reasons for those variations that are expected to have a significant effect on future services or liquidity.

GASB Statement 41, Budgetary Comparison Schedules—Perspective Differences (GASBS 41), addresses the issue of when significant budgetary differences result in a government’s being unable to present budgetary comparison information for the general fund and major special revenue funds. Governments are required to present budgetary comparison schedules as required supplementary information based on the fund, organization, or program structure that the government uses for its legally adopted budget. Basically, GASBS 41 provides that when there are significant perspective differences (perspective differences are described later in this chapter), the government is still required to present a budgetary comparison schedule. The schedule should use the perspective used in the legally adopted budget. However, this schedule must be reported as required supplementary information. The government in this situation does not have the option to present the budgetary comparison information in a budgetary comparison statement that is part of the basic financial statements.

WHICH FUNDS OF THE GOVERNMENT ADOPT BUDGETS?

NCGAS 1 states that an annual budget should be adopted by every governmental unit. However, the adoption of budgets may be different for governmental and proprietary activities. In practice, the extent to which budgets are adopted for all funds varies significantly among governments, and there is equal variability in the extent to which there are legally adopted (appropriated) budgets. The following paragraphs summarize some of the common considerations about the budgets for the various governmental funds.

General Fund

Almost universally, a budget is legally adopted for the general fund. Because the most significant operating activities of the government are normally found in the general fund, there is also usually a great deal of budget management in the general fund. This budget management means that the legally adopted budget is broken down into smaller allocations that enable the government’s management to manage the finances of the government’s general fund.

Special Revenue Funds

Budgets are usually legally adopted for special revenue funds. However, to the extent that special revenue funds are used to account for grants and other expenditure-driven revenues, governments may choose not to legally adopt budgets for special revenue funds that account for these activities. In these cases, the rationale is that the particular grants or contracts provide sufficient controls over expenditures (and their related revenues) so that a legally adopted budget is not considered necessary.

Capital Projects Funds

Budgets for capital projects funds differ from budgets for other funds because capital projects generally span more than one year. Therefore, governments are likely to adopt budgets on a multiyear project basis, rather than having annual appropriations for all capital projects. These multiyear project budgets may or may not be subject to approval of the legislature, based on the legal and operating environment of the particular government.

Debt Service Funds

Debt service funds adopt legal budgets infrequently. Debt service payments are determined under bond and note indentures and seldom require additional controls. In addition, governments normally transfer the annual debt service requirements of the debt service funds from the general fund to the debt service funds. The amount transferred from the general fund is already included in the legally adopted budget of the general fund. Governments should ensure, however, that they have in place a plan for debt service payments throughout the year so that as principal and interest payments or debt retirements occur, the debt service funds have sufficient resources to meet these obligations.

Proprietary Funds

Budgets are seldom legally adopted by proprietary funds. Proprietary funds often use budgeting in a manner similar to commercial enterprises. Budgets help proprietary funds determine whether their costs will be recovered or to estimate the amount of subsidy needed from the government if costs are not meant to be recovered. Proprietary fund budgets are sometimes referred to as “variable” or “flexible,” because the expense budgets fluctuate with the volume of the revenue-generating activities.

Fiduciary Funds

Budgets are infrequently adopted for fiduciary funds. Trust funds and agency funds are controlled by the specific contracts or agreements that cause these funds to be established. Control over these assets by a legal process outside of these contracts or agreements would lessen the validity of the contracts or agreements. For example, government employees often contribute to deferred compensation plans established under Section 457 of the Internal Revenue Code, which are accounted for as fiduciary funds. It would not be appropriate for the government to have to legally adopt a budget of the amount of estimated account withdrawals to be made during the upcoming fiscal year.

DIFFERENCES BETWEEN THE BUDGET AND GAAP

As previously mentioned, there may be differences between budgetary accounting and reporting and GAAP-based accounting and reporting. As will be described in Chapter 9, a government’s financial statements will include a financial statement that is actually prepared on the budgetary basis of accounting. NCGAI 10 describes the most significant categories that might give rise to these differences. These categories follow.

Basis of Accounting Differences

A government may choose to prepare its budget on a different basis of accounting than that required by GAAP. For example, while GAAP requires that the general fund use the modified accrual basis of accounting, a government may prepare its general fund budget on a different basis, such as the cash basis. Alternatively, a government may prepare its general fund budget on the modified accrual basis, with the exception of certain items that it elects to budget on a different basis, such as the cash basis.

Timing Differences

Budgets may be prepared using different time frames than the funds to which they relate use for financial reporting purposes. In addition, certain items (such as carryovers of appropriations) may be treated differently for budget purposes than for GAAP accounting and reporting. In some infrequent cases, governments adopt biennial budgets. One of the more common instances occurs when there are long-term projects that are budgeted for several years, while the fund that accounts for the construction activities (such as the capital projects fund) prepares an annual budget.

Perspective Differences

Differences sometimes arise because the fund structure that governs the way in which transactions are reported under GAAP may differ from an organizational or program structure used for budgeting purposes. NCGAI 10 defines the organizational structure as “. . . The perspective of a government that follows from the formal, usually statutory, patterns of authority and responsibility granted to actually carry out the functions of the government.” In other words, it reflects the organizational chart and the superior/subordinate relationships that exist in actually running the government. These relationships may be different than those that would be reported for GAAP purposes within the fund structure. The program structure is defined by NCGAI 10 as “. . . The grouping of the activities, assignments of personnel, uses of expenditure authority, facilities, and equipment all intended to achieve a common purpose.” In other words, budgeting may be performed on a project basis, while there may be various funds that pay for (1) the personnel assigned to the project (such as the general fund), (2) construction of the assets that the project personnel are using (such as the capital projects fund), and (3) the debt service on the money borrowed to construct the assets that the project personnel are using (such as the debt service fund).

Entity Differences

A government’s appropriated budget may not include all of the entities included in its reporting entity. This is particularly important when component units are “blended” with the funds that make up the primary government. (More information is provided on the reporting entity in Chapter 11.) Governments may also legally adopt budgets for some funds, but not for all funds of a particular type of fund. These other funds would fall within the “nonappropriation budget” described earlier in this chapter.

The question naturally arises of what to do when budgetary reporting differs from reporting under GAAP. NCGAI 10 affirms that differences between the government’s budget practices and GAAP not otherwise reconciled in the general-purpose financial statements that are attributable to basis, timing, perspective, and entity differences should be reconciled in the footnotes. Exhibit 2 provides an example of a reconciliation of a budget basis of accounting to a GAAP basis of accounting. It illustrates how this reconciliation may be shown in the notes to the financial statements.

BUDGETARY CONTROL

One of the primary purposes of budgeting is to provide control over the revenues and expenditures of the government. To achieve an appropriately high level of control, budgets must be integrated with the government’s accounting system. This is particularly relevant for expenditures. To control and limit expenditures by the accounting system, it must have mechanisms and controls in place to ensure that budgets are not exceeded.

The accounting system budgetary controls reflect the fact that budgets include various levels of detail. For example, expenditures may be budgeted on a fundwide basis. The fundwide basis may be further divided into governmental functions. The budget for each governmental function may be further refined into budgets for several departments or agencies that perform the function. Each department’s or agency’s budget may be divided into several activities. For each activity, there may be further divisions into specific expenditure objects (such as for the type of expenditures: personal services, postage, rent, utilities, and so forth). Objects may be divided into subjects (for example, full- and part-time personnel and managerial and nonmanagerial personnel).

One of the important concepts in understanding how these controls should be designed and implemented is the legal level of control. The legal level of control represents the lowest budgetary level at which a government’s management may not reassign resources without special approval. For an appropriated budget passed by a legislature, this special approval would encompass going back to the legislature to effectively have this body amend the law that adopted the original budget. The legal level of control can vary greatly from one government to another.

Although budgets are usually prepared at the level of detail described above, management often has the latitude to shift budget appropriations. This latitude is defined by each government. The accounting system must be able to accommodate this latitude, while at the same time ensuring that it is only used within the previously authorized parameters.

The budgetary controls used in an accounting system are more complicated than simply comparing actual expenditures to the total budget. Encumbrances must be considered, as well as any difference in the basis of accounting between the budget and GAAP. (Encumbrances represent commitments related to unfilled purchase orders or unfulfilled contracts. In other words, the government is committed or intends to spend the funds, but the actual goods or services have not been received. The encumbrance represents a “placeholder” that helps ensure that the budgeted funds for these commitments are not spent elsewhere.) Typically, a comparison of the expenditures authorized by appropriation is made with the sum of the following:

• Liquidated expenditures (goods and services have been received and the bill has been paid)
• Unliquidated expenditures (goods and services have been received, but the bill has not as yet been paid)
• Encumbrances (goods and services have not been received, but the government has committed to purchase [ordered] them)
• Preencumbrances (used by some governments when the government has not committed to purchase goods and services, but plans to in the future and wants to reserve the budget appropriation for these anticipated commitments)

The accounting system should consider all of these categories to effectively make budgetary comparisons, although many systems do not distinguish between liquidated and unliquidated expenditures. Most governments use at least some form of automated system designed to integrate these budgetary control comparisons. In “classical” governmental accounting, a budget entry is recorded on the books of the government to reflect the budget amounts. Often governments don’t actually record this entry on their books and rely on the automated controls instead. However, since this is a complete and comprehensive guide to governmental accounting and financial reporting, the following examples walk through the journal entries of a government to record its budget. Exhibit 3 provides examples of journal entries that would be recorded by a government to record a budget.

In recording journal entries for budgets, it’s important to keep in mind that at the close of the fiscal year, all budgetary journal entries should be removed from the books. Where encumbrances will be honored in following fiscal years, the effect on the books is solely the reservation of fund balance, which is not part of the “budgetary” journal entries that record and remove the budget from the books.

SUMMARY

As mentioned at the beginning of this chapter, budgets are an important part of maintaining control of a government’s finances and are a means of achieving the financial reporting objective of accountability. Careful attention and reporting of budget-related matters is an important consideration in governmental accounting and financial reporting.